Still ok to invest in rental if the rent a little less than mortage

[Shallin Partap Singh]

Hello Everyone,

I am new to Bigger Pockets and I just started listening to some investment tips from the podcast. I am glad that this community exists which can help/educate new investors like me.

I have a question:

We are almost close to putting in an offer on the first Rental Investment Property (Condo) we liked in the San Francisco Bay Area. So I was doing all the calculations like how much rent can I get (looking at the nearby similar properties) to check if it can cover the mortgage on the property or not. As we know interest rates are skyrocketing and with these rates (in 7's), the rent numbers are coming out to be a little less (a couple hundred) than the mortgage.

So my mortgage this this house will be ~ $3300 with 30% down (including HOA, homeowners insurance, and everything), but I will be getting ~$3100 rent.

My questions are:

1) Should I still pursue the offer? to increase my portfolio thinking that I can get it refinanced when the rates come down?

2) Should I put more down to make sure rent covers the mortgage?

What do you suggest?

[JD Martin]

Quote from @Shallin Partap Singh:

@Wilson Lau

@Wilson Lau / @JD Martin

Thanks for replying to my post:

I totally understand that putting 30% down is already very hard, but these days with the high-interest rates, It is so hard to find any investment rental property that can generate cash flow from the first day.

As a first-time investor, my goal is to put enough down payment so that the rent can cover the mortgage and then ideally forget about the investment so that it can slowly free on its own, thus increasing my portfolio in investment.

I tried finding a lot of different properties basically condos, single-family, and townhouses in East Bay but was not able to find a deal where with 20% down I could generate any cash flow with today's interest rates. 

That is why I thought of putting more down and hopefully refinancing it when the interest gets dropped by 1 or 2 points to actually start generating cash flow. Is it a wrong idea?

 Well, you have to remember that there are three main advantages to RE done right over other investments:

1. Leverage - you get to legally borrow money to buy an asset, which you generally cannot do in any proportional way on anything else (stocks, etc). Done to the extreme, you own a property that you don't have any of your own money in.

2. Principal pay-down - your tenant is paying off a portion of the borrowed funds for you.

3. Tax advantages - depreciation, etc.

What your investment should do is maximize these advantages and give you a return equal to or better than other comparable risk investments. So in your case here it should be:

(Appreciation + principal pay-down + tax advantages + net cash flow)  > return from other investments using same amount of down payment (opportunity cost).

Example: 3% appreciation on 500k, 250/mo principal pay down, minus -200 per month net income, tax advantages (assumed) zeroing your taxable income: $15k + $3k -$2400 = $15600. $150k (30% of 500k) x 5% interest in a CD = $7500. 

So on paper this looks like a good deal using my made up numbers, but you have to remember all the variables on the left side of that equation. What if appreciation is flat? Now you're well worse off. What if your net income falls in the toilet because of a couple months of vacancy? If that happens, you lose from all parts of your left side equation. The right side of this equation is a guaranteed event. Further, you don't get to use appreciation until or unless you refinance or sell the property, so it is phantom locked up money until then. 

Still, it could make sense if you were certain about the appreciation and could afford the cash flow hit/makeup with outside funds. RE is a long game and over the long run, especially using leverage, you are almost guaranteed to come out ahead so you are right in thinking of more angles than just cash flow today.